Boston Tea Party 2010: Changing Times in Reinsurance Disputes

Transcription

1 Boston Tea Party 2010: Changing Times in Reinsurance Disputes

2 Contract Wordings: Old Dilemmas and New Solutions Moderator: Elaine Caprio Brady Liberty Mutual Insurance Company Panelists: John Phillips General Re Corporation Julie Pollack, Esq. Swiss Re America Michael O Malley, Esq. Liberty Mutual Group Rhonda L. Rittenberg, Esq. Lexington Insurance Company

3 Agenda 1. Access to Records 2. Arbitration 3. Special Termination 4. Unauthorized Reinsurance 5. Contract Certainty

4 Disclaimer The views and opinions contained herein or expressed verbally in conjunction with this outline are those of the presenters and not those of their companies, or their companies management, shareholders or affiliates.

5 Access to Records John Phillips General Re Corporation

6 Access to Records Clause Overall Purpose of the Clause Provisions to allow Reinsurer to examine records which relate to coverage under the contract Contained in almost all reinsurance agreements

7 Access to Records Clause A Little History In the past, reinsurers relied on utmost good faith to ensure compliance with the underlying agreement Over the last few decades, differences and misunderstandings arose over some difficult areas, for example asbestos As a result, reinsurers felt a need to have a more accurate view of business ceded

8 Access to Records Clause Common Issues Involving this Clause Access limited to certain classes of documents How to address privileged documents (if at all) Meaning of not current on undisputed payments (See Items 3, 6)

9 Access to Records Clause Less Common Issues Involving this Clause Specific notice period before access stipulated (as opposed to reasonable notice ) (See Item 1) Exclusion of items beyond attorney-client privilege or attorney work product (e.g. Trade Secrets ) (See Item 4)

10 Access to Records Clause Limits on Classes of Documents Some clauses limit access to only claims and/or policy files and/or accounting records Some clauses limit access to only certain locations Access to all relevant records

11 Access to Records Clause Privileged Documents Regence vs. TIG - 9 th Circuit decision not to review Oregon District Court decision brief to appeal to U.S. Supreme Court Provisions to provide information without causing waiver (See Item 2) Full access provided when all litigation is exhausted Distinctions between privileged documents relating to disputes between Company and Reinsurer or arbitrations and other business

12 Access to Records Clause Not Current on Disputed Payments Provisions to define disputed or undisputed claim payments Distinction between legitimate, routine claim settlement discussions, legitimately disputed claims ; and failure to adequately explain non-payment (See Item 3)

13 Access to Records Clause Miscellaneous Access to documents under the control of third parties (TPA s; MGA s) Arbitration Clause waive judicial formalities / honorable engagement Right to make copies (See Item 5)

14 Access to Records Clause Checkpoints Access to all relevant records (not limited to certain classes of records or location of records) Ability to make reasonable copies Provisions to access records held by cedent s representatives (TPA s, MGA s) Provisions to protect privileged documents Provisions to find reasonable ways to share information which is under privilege Check Arbitration clause Clause survives termination of agreement

15 Julie Pollack, Esq. Swiss Re America Arbitration

16 Dispute Resolution in Reinsurance Agreements Historically, reinsurance agreements have required the parties to submit all disputes to arbitration. U.S. law strongly favors enforcement of agreements to arbitrate. E.g., Federal Arbitration Act, 9 U.S.C. 1 et seq. Recently, some participants in the industry have re-examined and revised traditional arbitration clauses.

17 Arbitration Current Topics 1. Disputes subject to arbitration 2. Framework of arbitration proceeding 3. Arbitrator qualifications 4. Authority of arbitrators 5. Arbitration Awards

18 Disputes Subject to Arbitration (1) Commonly, "... any and all disputes between [parties] arising out of, relating to, or concerning this Contract, whether sounding in contract or tort and whether arising during or after this Contract s formation, or after its termination, including disputes as to whether the Contract was validly formed or is voidable, shall be submitted to the decision of an arbitration panel." If no mandatory arbitration, recourse is in court Occasional exceptions to mandatory arbitration larger disputes (i.e. over $X million) disputes regarding contract formation

19 Disputes Subject to Arbitration Are state laws prohibiting arbitration of (re)insurance disputes enforceable? Louisiana statute prohibits arbitration of (re)insurance disputes: "No insurance contract... in this state... shall contain any condition, stipulation, or agreement:... (2) Depriving the courts of this state of the jurisdiction of action against the insurer." La. Rev. Stat. An. 22:868 The Convention on the Recognition and Enforcement of Foreign Arbitral Awards, dictates that signatories "shall recognize an agreement in writing under which the parties undertake to submit to arbitration..." June 10, 1958, 21 U.S.T. 2517, 330 U.N.T.S. 3.

20 Disputes Subject to Arbitration Does the McCarran Ferguson Act provide an answer? "No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance." 15 U.S.C The Fifth Circuit recently considered this question in Safety Nat l Casualty Corp. v. Certain Underwriters at Lloyd s, London, 587 F.3d 714 (5 th Cir. 2009).

21 Disputes Subject to Arbitration Safety Nat l, Holding: No reverse preemption. Jurisdiction to enforce the Convention does not arise solely from an Act of Congress." Dissent: Vigorously argued that enforcement jurisdiction arises only from the implementation legislation - an Act of Congress within McCarran Ferguson On appeal to U.S. Supreme Court How might this impact the ability of the Federal Insurance office to negotiate International Insurance Agreements?

22 Framework of Arbitration Proceeding (2a) So-called "ad hoc" procedures vs. institutional rules "Ad hoc": "Unless otherwise provided in... this Article, the arbitrator(s) shall meet within 30 days after appointment of all arbitrators, and determine a timely period for discovery, discovery procedures and schedules for hearings." "Institutional": "Except as provided herein, any arbitration shall be based upon the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes, Regular Panel Version, dated April 2004 (the Procedures ), developed by the Insurance and Reinsurance Dispute Resolution Task Force, subject to the following modifications:..." Other options: ARIAS, AAA, ICC, JAMS

23 Modified Procedures (2b) "Streamlined" arbitration, commonly involving, Smaller disputes Single arbitrator Shorter timeframes Limited or no discovery

24 Modified Procedures (2b) Baseball Arbitration Parties submit competing settlement offers Arbitrator is required to select one of the submitted settlement offers Often shorter timeframes, with limited or no discovery Dispute may be submitted to a single arbitrator

25 Arbitrator Qualifications (3) Limit candidates to executives or expand to other industry officers and other professionals, or retired judges Umpire selection: Drawing lots, ARIAS selection, Lists maintained by third parties Neutral panels: Why are these not utilized more often?

26 Authority of Arbitrators (4) Panel sometimes, but not always, bound by substantive law "... the arbitrator(s) shall apply the substantive law of the jurisdiction indicated in Part I of this Article.... " "The arbiter... may abstain from following the strict rules of law." Clause may dictate law governing procedural matters, whether or not it dictates substantive law. How might an "honorable engagement" clause impact the process? "The arbiter shall consider this Contract as an honorable engagement rather than merely as a legal obligation... "

27 Arbitration Awards (5) Punitive and exemplary damages "In no event may the arbiter award punitive, exemplary or enhanced compensatory damages." Interest, costs, attorney fees "Notwithstanding the above, the arbiter may award interest and costs, including attorney fees." "The prevailing party shall be entitled to recovery of costs and reasonable attorneys fees.

28 Special Termination Michael O Malley, Esq. Liberty Mutual Group

29 Special Conditions/Funding Allows party (generally cedant) to manage credit risk by allowing termination of reinsurance and/or requiring counterparty to post security and/or commute upon occurrence of certain trigger events Trigger events = matters giving rising to credit risk; e.g. financial downgrades Remedies available generally reflect relative bargaining position of parties

30 Some Trigger Events Insurance Dept orders reinsurer to stop writing business Reinsurer is placed in insolvency or receivership Reinsurer voluntarily withdraws from business; e.g. stops writing assumed reinsurance

31 Trigger Events-Notice Notice to counterparty of trigger event typically required -notice period varies -may be subject regulatory constraints May require notice as condition to exercise of rights

32 Surplus Reduction Trigger Reinsurer s policyholders surplus or equity: has been reduced by 25% or more from the amount on the effective date of this Contract; or has been reduced by 25% or more in any period of twelve (12) months or less after the effective date of this Contract.

33 Trigger Event Rating Downgrade Commonly requires a drop below a tier 1 rating (A.M. Best A- or S&P A- ) The Reinsurer s A.M. Best s financial strength rating has been assigned or downgraded below A- or S&P s financial strength rating has been assigned or downgraded below A-

34 Change in Control Trigger Cedant s perspective--if new party acquires control of reinsurer (e.g. merger) this may increase credit risk Reinsurer s perspective--change in control triggers diminish value of reinsurer s business; hindrance on ability to merge, acquire

35 Special Conditions--Remedies Termination of contract at cedant s option --timing of termination may vary, based on trigger --runoff or cutoff Possible cure, typically by posting collateral --cure of termination? Forced collateral or commutation?

36 Special Conditions Acceleration of Financial Obligations Mandatory Funding reinsurer must post collateral if trigger event occurs --may appear in Special Conditions or Reserves and Funding clause Mandatory commutation if trigger event occurs

37 Reinsurers Objections to Acceleration of Financial Obligations Run on the bank - will mandatory funding/commutation make bad situation worse? False sense of security? Risk factor to be included in public filings/rating agency disclosures If insolvency ensues, voidable preference issues

38 Credit Risk Mitigation Other Than Forced Collateralization Funds withheld LOC or trust agreements funded with some portion of ceded earned premium Trust agreements covering all reinsurance business between parties Commutation at present value with option to cure commutation by funding

39 Unauthorized Reinsurance Rhonda L. Rittenberg, Esq. Lexington Insurance Company

40 Purpose Unauthorized Reinsurance Clauses Require posting of collateral in order for a U.S. ceding company to take statutory credit for reinsurance from an unauthorized reinsurer

41 Fundamentals FORM OF COLLATERAL: a. Letter of Credit b. Trust Fund c. Funds Held

42 Fundamentals COLLTERAL EQUAL TO AT LEAST 100% OF REINSURER S CONTRACTUAL OBLIGATIONS OBLIGATIONS STATUTORILY DICTATED: a. Unearned premium reserve; b. Paid loss and LAE not recovered from Reinsurer; c. Outstanding Loss and LAE reserves; and d. IBNR

43 Provisions of Interest Reinsurer s Obligations definition does not include IBNR (See Clause #1) Letter of Credit- Under no circumstances shall any amount in respect of incurred but not reported losses be included in the amount of the Letter of Credit.

44 Provisions of Interest Replacement Letter of Credit If the Company has concluded that the issuing bank s financial condition is such that the value of the security represented by the Letter of Credit may be in jeopardy, the Company may require that a replacement Letter of Credit be issued by a bank acceptable to the Company (See Clause #3)

45 Provisions of Interest Specific arbitration clause: Any and all disputes between the Company and Reinsurer arising out of this Article shall be resolved pursuant to the ARIAS-U.S. Newer Arbitrator Program. Unless the Parties otherwise agree, the ARIAS-U.S. Newer Arbitrator program expedited proceeding with a single Newer Arbitrator shall be used to resolve any such disputes. (See Clause #3)

46 Provisions of Interest Ownership of Loss Deposits : The sums so deposited by the Reinsurers to cover their liability towards the Company shall remain the sole property of the Reinsurers. However, if the Reinsurers fail to fulfill their obligations, the Company shall automatically become the owner of such sums [N]o creditor of the Company or the Reinsurers shall have any right to these sums (See Clause #4)

47 Changes to Regulatory Landscape Collateral requirements being revisited under NAIC Reinsurance Regulatory Modernization Act of 2009 August 2010, NAIC Reinsurance (E) Task Force issued Reinsurance Collateral Reduction and Accreditation Recommendations exposure draft for comments by September 16, 2010 Rationale for easing collateral requirements: Domestic and foreign reinsurers should be treated equally (i.e., level the playing field) Current approach does not recognize financial strength or solvency criteria of foreign reinsurers, arguably raising costs by limiting access to non-us reinsurers European reinsurers, led by Lloyd s, have lobbied for years to remove collateral requirements

48 Changes to Regulatory Landscape Many domestic insurers oppose collateral reduction because: Less security to cedent than current system provides Enforcement of judgment issues Need for analysis of foreign regulatory schemes and accounting standards Lack of evidence that capacity will increase as a result

49 Florida Proposal In 2007, Florida Office of Insurance (OIC) Regulation proposes lower collateral for non-licenses reinsurers Reinsurers rated AA (or higher) by two rating agencies would receive full credit Collateral requirements for others on a sliding scale based on ratings In 2010, XL Re Ltd (Bermuda reinsurer), received approval by OIC to qualify as eligible reinsurer

50 New York Proposal Since 2007, NY Insurance Dept. has proposed several amendments to Regulation 20 concerning credit for reinsurance. In summer 2010, NY Dept. releases an outreach draft of proposed Tenth Amendment to Regulation 20 to take effect July 11, 2011.

51 New York Proposal Highlights of Current Proposal: Superintendent has discretion to allow a reduction in collateral for qualifying reinsurers with respect to NY domiciled cedents Baseline eligibility for unauthorized reinsurers to provide reinsurance with reduced collateral requirements: Maintain policyholders surplus in excess of $250M (on US GAAP or SAP basis); Be rated by at least two rating agencies recognized by the Superintendent; File with the Superintendent information specified in regulation

52 New York Proposal If a non-us reinsurer, must be organized in a jurisdiction recognized by the Superintendent as providing access to US reinsurers on terms and conditions that are at least as favorable as those provided to non-us reinsurers under the laws of NY Memorandum of Understanding (MOU) between the Superintendent and the applicant s domiciliary regulator that addresses relevant matters

53 New York Proposal Collateral Reduction Tied to Factors/Ratings: Superintendent will assign one of five ratings (i.e. Secure-1 to Vulnerable-5) RATING COLLATERAL REQUIRED A.M. BEST S&P MOODY S FITCH Secure-1 0% A++ AAA Aaa AAA Secure-2 10% A+ AA+, AA, AA- Aa1, Aa2, Aa3 AA+, AA, AA- Secure-3 20% A, A- A+, A, A- A1, A2, A3 A+, A, A- Secure-4 75% B++, B+ BBB+, BBB, BBB- Baa1, Baa3 Baa2, BBB+, BBB, BBB- Vulnerable % B, B-, C++, C, C-, D, E, F BB+, BB, BB-, B+, B, B-, CCC, CC, C, D, R, NR Ba1, Ba2, Ba3, B1, B2, B3, Caa, Ca, C BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, DD

54 New York Proposal Percentages and ratings consistent with NAIC Reinsurance Regulatory Modernization Act of 2009 Additional considerations by Superintendent: Compliance with reinsurance contractual terms and obligations; Business practices of the reinsurer in dealing with its ceding companies

55 New York Proposal Reinsurer s reputation for prompt claims payments; For US reinsurers, a review of Annual Statement; Regulatory actions against reinsurer; Independent audit opinion of the reinsurer; Audited financial statements; Liquidation preference of obligations to the ceding company in reinsurer s domicile; Reinsurer s participation in any solvent scheme of arrangement that involves US cedents; and Any other information deemed relevant by Superintendent

56 New York Proposal Other Requirements: Reinsurance Agreements must include: Insolvency clause Service of process and consent to jurisdiction of US courts provisions (expressly recognizes that these provisions do not trump any arbitration clause) NY governing law

57 New York Proposal Annual Filing Requirements include * Audited financials * Report in form of Schedule F or S to Annual Statement blank * Certificate of good standing * List of disputed recoverables with cedents.

58 New York Proposal Prudent Reinsurance Credit Risk Management Ceding companies must act with financial prudence and consider net retained risk, risk concentration and credit risk Ceding companies required to notify Superintendent if reinsurance recoverables from a single reinsurer or affiliated group exceeds 50% of policyholder surplus or if ceded premiums are more than 20% of gross written premium in prior calendar year

59 New York Proposal Multi-Beneficiary Reinsurance Trusts Superintendent may approve reduction in MBRTs to less than $20M (but not less than 30% of reinsurer s liabilities to US cedents), if reinsurer has discontinued underwriting new business for at least three years; and New required surplus is deemed adequate for protection of US cedents.

60 New York Proposal Concerns: Rating/Reduction matrix requires only 20% collateral for A- rated reinsurers; Matrix allows a 25% reduction for reinsurers rated as low as S&P BBB- (defined as one notch above marginal ) Too big of a drop between Secure 3 (20%) to Secure 4 (75%). A drop from Secure 3 to Secure 4 could create a run on the bank and hamper ability to secure increased collateral

61 New York Proposal WHICH ONE TRUMPS-FEDERAL OR STATE?: Dodd-Frank Act provides authority to Secretary of the Treasury to negotiate and enter into international insurance agreements. Act goes into effect on July 21, 2011 To assure uniform, national application of prudential measures such as reinsurance collateral requirements, the Federal Insurance Office ( FIO ) has authority to identify and narrowly preempt state insurance measures inconsistent with international insurance agreements. Does New York proposal preempt an international insurance agreement collateral requirement or vice versa?

62 New York Proposal Other Concerns: Lloyd s trust fund (MBT) could be reduced to amounts significantly less than its actual liabilities. MBTs may no longer satisfy other states credit for reinsurance laws and could adversely impact US cedents domiciled outside of NY

63 New York Proposal Implementation of collateral reform on a single-state, piecemeal basis could pose problems for US cedents that have affiliates/subsidiaries domiciled in different states; Many open questions surrounding Solvency II effects; CEIOPS recent omission of the US from first round of equivalency testing raises question as to whether NY proposal will achieve global level playing field

64 New York Proposal Does the NY Dept have resources and expertise to conduct international financial and regulatory analysis of unauthorized reinsurers? Will eliminating collateral for reinsurers place new burdens on US cedents, including challenges in receiving prompt reinsurance payments and ability to satisfy judgments? Note: NAIC Reinsurance Task Force exposure draft requires unauthorized reinsurer to post 100% collateral if it resists enforcement of a US judgment.

65 New York Proposal If NY Proposal is adopted, NY domiciled cedents likely to experience a decline in collateral from offshore reinsurers (e.g. Bermuda) 80% -100% reduction in most cases Will this have desired effect of opening the US market to foreign reinsurers in current capital crunch? Many in industry urge states to postpone changes pending NAIC action to ensure uniform approach

66 Contract Certainty Julie Pollack, Esq. Swiss Re America

67 Contract Certainty Under discussion in several forums NAIC Reinsurance Task Force continued its dialog on contract certainty at an August 2010 meeting, considering, IAIS (Int'l Assn. of Insurance Supervisors) project to develop and publish revised standards on finalization of reinsurance contracts Paragraph 24 of SSAP 62R ("9 month rule") UK FSA Contract Certainty Code of Practice Principles & Guidance. Bermuda Market Contract Certainty Code of Practice & Guidelines New York State Insurance Department Circular Letter No. 20 and Supplement 1 Detailed discussion was tabled for a future meeting

68 United Kingdom Contract Certainty Global Initiatives [C]ontract certainty is achieved by the complete and final agreement of all terms between the insured and the insurer by the time that they enter into the contract, with contract documentation provided promptly thereafter. Bermuda Full and final agreement of all terms and conditions between the (re)insurer and the (re)insured at the time of binding. This will be evidenced by a binder, cover note or similar which reflects all terms and conditions and which is agreed by the (re)insurer. IAIS draft guidance The supervisory regime must require that parties to reinsurance agreements promptly document the principal economic and coverage terms agreed by the parties [and] finalize the formal reinsurance agreement in a timely fashion preferably before the inception of coverage.

69 Contract Certainty: NY Initiative New York Insurance Department Circular Letter 20 (Oct. 2008) and Supp. 1 (Feb. 2010) Applies to property and casualty (re)insurers doing business in New York (not life and health) (Re)insurers should implement practices to assure that policy documentation is delivered to the insured by or promptly after inception. Promptly generally means within 30 business days Parties and producers are free to allocate time Extensions should be carefully documented and, where possible, good cause established

70 Contract Certainty: NY Initiative What is policy documentation?... should contain all the agreed terms of the contract, and may include an insurance policy, binder of insurance, schedule of cover, signed contract wording, endorsement, or a complete slip. Similarly, documentation of a reinsurance contract can be evidenced by a binder, cover note, or similar documents, provided that it reflects all agreed terms and conditions to which the reinsurers have agreed.

71 Contract Certainty: NY Initiative Anticipated enforcement "The Department will verify industry s progress... through the examination process, inquiries to licensees, or information obtained from insureds or other parties affected..."... "the Department will focus its resources on those types of policies where, because of the unique nature or size of the risk, issues regarding contract certainty are most apt to surface... [including]: (1) large commercial insureds, written on a standard or manuscript basis; (2) the special risk market, written pursuant to Insurance Law Article 63; (3) policyholders in the excess line market; and (4) other insurers via reinsurance. "In the latter half of 2010, the Department may issue letters of inquiry... regarding how, and to what extent, licensees have developed and implemented practices to assure that contract certainty is routinely achieved."

72 MASSACHUSETTS REINSURANCE BAR ASSOCIATION ANNUAL SYMPOSIUM SEPTEMBER 23, 2010 Harvard Club Back Bay Boston, Massachusetts